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Target-Date Funds: A Bullseye Retirement Solution?

Assets in the funds have soared. But RIAs need to be aware of some nuances before they recommend them to their clients.

Investors are pouring money into target-date mutual funds, and many financial advisers say the funds make sense as a core retirement holding. “I like the idea, because the funds are self-rebalancing and get more conservative as the investor gets closer to retirement,” says Tom Fredrickson, a New York City financial adviser in the Garrett Planning Network. “It’s one-stop shopping for retirement funds.”

Assets in target-date funds soared to $790 billion at March 31, from $340 billion on December 31, 2010, according to the Investment Company Institute.

The crucial issues for registered investment advisers in deciding whether to recommend a target-date fund for their clients are the fund’s asset allocation, its glide path, the quality of the underlying funds within the target-date fund and expenses.

As for asset allocation, target-date funds generally begin with a heavy weighting in stocks and a light weighting in bonds. This makes sense, as younger investors can handle the higher historical risk of equities given their better historical returns, advisers say.

But it gets tricky for older investors. Among that group, some will want a greater exposure to stocks than others, but if they’re in the same fund, they’ll have the same exposure. “Many funds are 60 percent in bonds for people in their 50s and 60s. But that might not work for everyone,” says Jack Riashi, a financial adviser at Bloom Asset Management in Farmington Hills, Michigan. “It might be too conservative for some.”

The allocation may also be too aggressive for others. In 2008, numerous target-date funds had a heavy stock weighting for investors close to retirement, causing them great heartache when the stock market plunged in 2008-’09.

So advisers have to pay close attention to the fund’s glide path. They also must check whether the fund is a “glide to,” which means the allocation is static after the retirement date, or a “glide through,” which means the fund continues to rebalance after that date. “You do need to pay attention to asset allocation to make sure it’s compatible with your own risk tolerance,” Fredrickson says.

For investors who want more than just blue-chip stocks and plain-vanilla bonds, target-date funds have expanded in recent years to include small-cap stocks, emerging-markets stocks and bonds, real estate and natural resources.

So do these more varied funds make sense? “Alternative asset classes can have a valuable role,” says Jeff Holt, associate director of multi-asset strategies at Morningstar in Chicago. “It all goes back to the goal of diversifying for a smoother ride in retirement.”

But you’re still relying on your fund manager to choose investments well, he notes. “I would caution against adding asset classes just for the sake of it. And for a while, some funds seemed to be doing that, increasing their fees in the process.”

Since a target-date fund is just a fund of funds, RIAs should look carefully at the underlying funds’ makeup and performance. “Fund companies often invest in their own proprietary funds,” Holt says. “They aren’t always best in class. See if the company’s best funds are included.”

The good news is that target-date fund fees are dropping. The average asset-weighted expense ratio for a target-date fund series dwindled to 0.73 percent as of December 31, 2015, from 1.03 percent six years earlier, according to Morningstar.

Target funds have access to low-price shares of their underlying funds, and some invest in exchange-traded funds. Fredrickson likes Vanguard funds for their low expenses and has one himself as his largest retirement holding. “I do that with my wife in mind, knowing that if I die, there’s little she’ll have to do when she takes it over.”

The hands-off approach is a benefit for many investors. “Target-date funds are appealing to millennials for their low maintenance, immediate diversification and lack of complexity,” says Michael Sheldon, an independent market strategist in Westport, Connecticut.

But he and others warn against a complacent approach to target-date funds. “They are not a guarantee of sufficient retirement savings or a steady retirement income stream,” Holt says.

More knowledgeable investors can create their own balanced portfolio that exactly matches their asset-allocation desires and avoids the fees of a target-date fund, Sheldon notes. “But that does take homework.”

Get more on registered investment advisers.

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